Updated on March 3, 2023
A stochastic Oscillator is a technical indicator used in financial analysis to determine overbought or oversold conditions in an asset’s price. It compares the closing price of an asset to its price range over a set time period, typically 14 days. The oscillator generates a value between 0 and 100, with readings above 80 indicating an overbought market, and readings below 20 indicating an oversold market.
What is the formula to calculate a stochastic oscillator?
The formula to calculate the Stochastic Oscillator is as follows:
%K = (Current Close – Lowest Low)/(Highest High – Lowest Low) * 100
%D = 3-day Simple Moving Average of %K
Current Close is the closing price of the asset for the current period.
Lowest Low is the lowest low of the asset over the set time period.
Highest High is the highest high of the asset over the set time period.
%K is the current value of the Stochastic Oscillator.
%D is the 3-day simple moving average of %K, which is often used as a signal line.
What are the uses of the Stochastic Oscillator?
The Stochastic Oscillator is used for the following purposes –
Overbought/Oversold Indicator – It helps to identify whether an asset is overbought or oversold by measuring its closing price in relation to its price range.
Trend Identification – The direction of the %K line can be used to determine the trend of an asset. A rising %K line indicates an uptrend, while a falling %K line indicates a downtrend.
Spotting Divergences – The Stochastic Oscillator can be used to spot divergences between the asset price and the oscillator, which can indicate a potential trend reversal.
Generating Trading Signals – The Stochastic Oscillator can be used to generate buy and sell signals. For example, a buy signal is generated when the %K line crosses above the %D line, while a sell signal is generated when the %K line crosses below the %D line.
Confirming Trend Strength – The Stochastic Oscillator can be used to confirm the strength of a trend by measuring the momentum of an asset’s price. The higher the value of the oscillator, the stronger the trend.